Chapter 21Accounting for LeasesProblem 1 (from Alternate Exercises and Problems for use with Intermediate Accounting, Third Edition; Spiceland, Seppe, and Tomassini)

Hanson Company manufactures a computer with an estimated economic life of 5 years and leases it to Flypaper Airlines on January 1, 2014, for a period of 3 years. The normal selling price of the equipment is $275,000, and its unguaranteed residual value at the end of the lease term is estimated to be $20,000. Flypaper will pay annual payments of $95,036 at the beginning of each year and all maintenance, insurance, and taxes estimated at $5,000 per year. Hanson incurred costs of $135,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. Hanson has determined that the collectibility of the lease payments is reasonably predictable and that no additional costs will be incurred. The lessees incremental borrowing rate is 11% and the lessors implicit rate is 10% (unknown to the lessee).

Required:

1. Calculate the present value of the minimum lease payments to be paid by Flypaper Airlines.

2. Prepare an amortization schedule for Flypaper Airlines lease payments.

3. Record all entries required on Flypaper Airlines books relating to the lease for the years ending December 31, 2014 and 2015.

4. Record the return of the equipment at December 31, 2016.